The Federal Reserve’s preferred inflation indicator, Personal Consumption Expenditures (PCE), was updated this morning with August’s numbers. PCE measures inflation more accurately than the more widely reported Consumer Price Index (CPI). It also bears mostly bad news this month.
The PCE index increased by 0.3 percent in August, up from a 0.1 percent decline the previous month. It is up 6.2 percent from a year ago. It remains well below May’s 0.6 percent and June’s 1.0 percent readings, but still stubbornly high.
More troubling is the Core PCE reading. Core PCE is calculated identically to the standard PCE, but removes energy and food prices, which are prone to inflation-unrelated supply and demand swings. As the worst of COVID passed, energy prices ticked up from abnormally low levels as people reemerged from lockdowns and began using more energy. Putin’s invasion of Ukraine in February 2022 sparked a second price increase due to an unexpected supply shock.
During this period, PCE and CPI both slightly overstated inflation, since both rounds of energy price increases were creatures of supply and demand. They did not affect the number of dollars in circulation, which is what determines the overall price level—and the inflation rate. As a result, Core PCE consistently ran lower than the overall PCE number. In other words, inflation wasn’t quite as bad as the headlines said.
Now that energy prices have been falling, the opposite is happening. Inflation is now slightly worse than the headlines say. The overall PCE of 0.3 percent is understating monetary inflation, because falling oil prices are covering up other increases due to money supply growth. The Core PCE, at 0.6 percent, is now double the overall PCE number, and gives a more accurate picture of inflation.
It is still likely that inflation has either already peaked, or is about to. The Federal Reserve, in part to pay for trillions of dollars of bipartisan COVID-19 stimulus spending, increased the money supply by 40 percent in 2020 and 2021, while real output grew by only 4 percent. That imbalance is responsible for the vast majority of today’s inflation.
Starting in March 2022, the Fed slowed down its money supply growth. The M2 money supply measure actually declined slightly in April, and has been mostly flat since May.
The Fed’s actions have long and variable lag times, typically estimated at six to 18 months. While the scale of the COVID money creation spree is unprecedented, we are now entering the window where the Fed’s corrections have had about enough time to make themselves known throughout the larger economy.
As August’s numbers show, there may still be bumps in the road. There are enough non-monetary factors affecting prices, such as energy shocks and supply chain problems, that inflation indices such as PCE and CPI are still giving noisy readings. And the fact that both CPI and PCE’s Core readings are currently higher than their overall readings is concerning.
While today’s inflation is still unlikely to be as severe as it was during the worst of the 1970s stagflation, it is still the worst we’ve seen since then. Even in the best-case scenario, the Fed won’t hit its 2 percent target inflation rate until well into next year. Today’s PCE release may have made the wait longer still. We’ll know more when September’s PCE is released on October 28.